Unit 4 INTRODUCTION TO FINANCIAL ACCOUNTING. Need for ACCOUNTING As you are aware, every trader generally starts business for purpose of earning profit

Unit 4INTRODUCTION TO FINANCIAL

ACCOUNTING

Need for ACCOUNTING• As you are aware, every trader generally

starts business for purpose of earning profit.

• While establishing business, he brings own capital, Then he purchases machinery, furniture, raw materials and other assets.

• He starts buying and selling of goods, paying for salaries, rent and other expenses, depositing and withdrawing cash from bank. Like this he undertakes innumerable transactions in business.

Observe the following transactions of small trader

• Purchase of raw materials from Sri Ram 5000.• Goods sold for cash 6000• Sold gods to Sham on credit 3000• Advertising expenses 100• Stationary expenses 150• Withdrawal for personal use 200• Rent paid through cheque 500• Salaries paid 200• Received cash from Sham 3000

• The number of transactions in an organization

depends upon the size of the organization• In small organizations, the transactions

generally will be in thousands and in big organizations they may be in lakhs.

• It is humanly impossible to remember all these transactions. Further, it may not be possible to find out the final result of the business without recording and analyzing these transactions.

• Accounting came into practice as an aid to human memory by maintaining a systematic record of business transactions.

DEFINITION OF ACCOUNTANCY

o “Accountancy is the science of RECORDING and CLASSIFYING business transactions and events, primarily of financial character and the art of making significant SUMMARIES, ANALYSIS & INTERPRETATIONS of those transactions and events, & COMMUNICATING the results to persons who make decisions or form judgments”

Smith & Ashburne

• American Institute of Certified Public Accountants (AICPA): “The art of recording, classifying and summarizing in a significant manner and in terms of money transactions and events, which are in part at least, of a financial character and interpreting the results thereof.”

• Thus, accounting is an art of identifying, recording, summarizing and interpreting business transactions of financial nature. Hence accounting is the Language of Business.

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Objectives of Accountancy• To keep permanent, accurate and complete

record of business transactions• To maintain records of incomes and expenses

and losses in such a way that, the Net profit/Loss for any specified period is ascertained

• To maintain records of Assets and Liabilities and in such a way that, the Financial position of the business at any point is ascertained

• To provide information for legal & tax purposes.

Accounting Principles• Accounting principles are general rules

adopted in accounting• These principles enables standardization in

recording & reporting of financial information• Accounting principles may be defined as those

rules of conduct or procedures which are adopted by the accountants universally while recording the accounting transactions.


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Double entry system of Accounting• According to this system of Accounting every

transaction has two fold aspect.i.e., One party receiving benefit & Other party giving benefit• Every transaction is divided in to two aspects

Debit & Credit.• The basic principle of Double entry system is

FOR EVERY DEBIT THERE IS CORRESPONDING CREDIT OF EQUAL VALUE.

Basic Books of Accounts• An account is a summary of the record of all

the transactions relating to particular Person, Asset, expense or gain.

An account has two sides• left side of the account is called Debit side• right side of the account is called Credit side

CLASSIFICATION OF BUSINESS TRANSACTIONS

All business transactions are classified into three categories:

• 1.Those relating to persons• 2.Those relating to property Assets)• 3.Those relating to income & expenses Thus, three classes of accounts are

maintained for recording all business transactions. They are:

• 1.Personal accounts• 2.Real accounts• 3.Nominal accounts

• 1.Personal Accounts :Accounts relating to persons & artificial persons are called “Personal Accounts” .

• A separate account is kept on the name of each person for recording the benefits received from ,or given to the person in the course of dealings with him.

E.g.: • Krishna’s A/C,• Gopal’s A/C,• Nagarjuna Finances Ltd.A/C,

• 2.Real Accounts: The accounts relating to properties or assets are known as “Real Accounts” .

• Every business needs assets such as machinery , furniture etc, for running its activities .A separate account is maintained for each asset owned by the business .

• E.g.: • Cash A/C• Furniture A/C• Building A/C• Machinery A/C etc.

• 3.NominalAccounts:Accounts relating to expenses, losses, incomes and gains are known as “Nominal Accounts”. A separate account is maintained for each item of expenses, losses, income or gain.

• E.g.: Salaries A/C, Stationery A/C, Wages A/C, Postage A/C, Commission A/C, Interest A/C, Purchases A/C, Rent A/C, Discount A/C, Commission received A/C, Interest received A/C,Rent received A/C, Discount received A/C.

Basic Accounting rules• Before recording a transaction, it is necessary

to find out which of the accounts is to be debited and which is to be credited. The following three different rules have been laid down for the three classes of accounts….

• 1.Personal Accounts: The account of the person receiving benefit (receiver) is to be debited and the account of the person giving the benefit (given) is to be credited.

• 2.Real Accounts: When an asset is coming into the business, account of that asset is to be debited .When an asset is going out of the business, the account of that asset is to be credited.

• 3. Nominal Accounts: When an expense is incurred or loss encountered, the account representing the expense or loss is to be debited . When any income is earned or gain made, the account representing the income of gain is to be credited.

Summary of Accounting rulesPersonal account Rule: “Debit----The Receiver

Credit---The Giver”Real account Rule:

“Debit----What comes in Credit---What goes out”

Nominal account Rule: “Debit----All expenses and losses

Credit---All incomes and gains”


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Journal• The book in which the business transactions

are recorded in a chronological order, after analyzing them and classifying the benefits according to the principles of debit & credit is called JOURNAL.

• As all the day to day transactions are recorded in journal, this book is also called as “Day book” or Daily record”

• All the transactions related to business like Purchases, Purchase returns, sales, sales returns, cash receipts, cash payments, loans & advances taken (given), assets acquired, salaries paid are first recorded in the book of JOURNAL.

• Hence Journal is called as “BOOK OF PRIME ENTRY”.

JOURNAL ENTRY• The process of recording the business

transactions in a chronological order in the journal after analyzing, classifying & identifying them as Dr and Cr is called entry.

• All the transactions are recorded in the book of Journal are in the form of Entry.

• For easy identification of the transaction a brief description is given under each entry with in brackets. (Narration)

Journalize the following transactions

1. Ram commenced business with Rs 50,0002. Purchase furniture for cash Rs 3,0003. Purchase machinery from Manoj on credit

Rs 40,0004. Received cash from pavan Rs 8,000 on

account5. Paid rent to land lord Rs 5,000

• Jan 1 Raja commenced business with Rs 50,000

• Jan 2 Deposited in bank Rs 40,000• Jan 5 Purchased goods from Krishna on credit

Rs 10000• Jan 7 Sold goods to ram on credit 8,000• Jan 9 Purchased goods from Mahesh for cash

5000• Jan 12 Sold goods for cash to sailesh 8500

Journalize the following transactions

• Jan 15 purchased machinery from ajay engineering company, payment made by cheque 20,000

• Jan 18 Issued cheque to Krishna 7500• Jan 20 Received interest from raja 700• Jan 22 Cash withdrawn from bank for office

use 2000• Jan 24 Amount with drawn from bank for

personal use 800• Jan 27 Loan taken from rajiv varma 15000

• Jan 29 Cash with drawn from office for personal use 1000

• Jan 30 Goods withdrawn for personal use 2000

• Jan 31 Paid rent to landlord by cheque 600

Ledger• Introduction• Journal cannot give net results of various

transactions related to any account, at a given date the full information is not made available, with regard to value of assets, incomes & expenses.

• This limitation can be overcome by opening a LEDGER, which shows the net results of different accounts on given date.

• LEDGER is also called the “Book of final entry”

• From the LEDGER it is not possible to know the total purchases, sales, rent, salaries paid etc, this limitation can be over come by LEDGER.

• LEDGER : It is a book, where the various accounts pertaining to particular person, asset, expense are grouped together in one place in the form of an account.

• The process of transferring the transactions from JOURNAL to LEDGER is called “POSTING”

• LEDGER is the principal book of business & hence called “king of books of accounts”

1. Journalize the following transactions, post them into ledger and balance the accounts.

Jan 1kittu commenced business 1,00,000Jan 2 purchase goods from Ravi 10,000Jan 4 sold goods to gopi 20,000Jan 5 cash purchases 20,000Jan 7 paid salaries 5,000Jan 8 sold for cash 15,000Jan 9 purchased furniture paid by cheque

2,000

Jan 9 brought goods from Sobhan 10,000Jan 14 cash paid to ravi 9800, discount received 200Jan 17 received cash from gopi 19,500, discount allowed 500Jan 18 deposited with bank 10,000Jan 20 Paid for advertisement by cheque 700Jan 22 Stationary expenses 800Jan 24 Sold old furniture 1,700Jan 28 Paid cash to shoban 4,000Jan 26 Received interest through cheque (sent to bank on the same day) 500Jan 31 Proprietors personal use 1,000

Trial BalanceINTRODUCTION The Trial Balance contains the debit and credit

balances of all LEDGER accounts, it is very much useful in preparation of FINAL ACCOUNTS.

It is a connecting link between the LEDGER & FINAL ACCOUNTS.

Trial Balance can be prepared at any time & not necessarily at the end of a calendar or accounting year.

It is the only base for preparation of FINAL ACCOUNTS

• Your are requested to prepare the Trial Balance from the Ledger account balances.

capital 65,500 bills payable 4,500 Creditors 18,200 reserve for bad debts 3,250Debtors 21,350 tax outstanding 1,110Cash 6,750 interest on investment 2,150Sales 1,20,000 drawings 1510Purchases 69,100 fixed deposits 45,000Cash at bank 7,800 Rent 9,50Machinery 35,000 Insurance prepaid 4,200Discount allowed 5,000 Wages 3,150Discount received 3,200 Salaries outstanding 7,200Furniture 4,000 bills receivables 21,300.

Trading Account• Trading account is prepared at the end of each

accounting period to assess the GROSS PROFIT/LOSS.

• GROSS PROFIT = Net sales – COGS• GROSS LOSS = COGS – Net sales• Net sales = sales – sales returns• COGS or cost of production or cost of goods

sold = opening stock + purchases + direct expenses – closing stock

• Direct expense: the following are direct expenses

carriage inwardwages cartage or freightimport duty excise duty coal, fuel, power factory expense, manufacturing expenses.

Particulars amount Particulars amount

To opening stockTo purchases xxxxLess: returns xxTo carriage inwardsTo wagesTo freight/cartageTo customs dutyTo gas, fuel, coalTo factory expensesTo other man. ExpensesTo productive expenses

To gross profit c/d(Transferred to P&L account)

Xxxx

XxxxxxxxXxxxXxxxXxxxXxxx

By sales xxxxLess: returns xxxBy closing stockBy goods destroyed by fireBy gross loss(Transferred to P&L account)

xxxxXxxxxxxx

Trading account proforma

Profit & Loss account

• It is prepared to ascertain the Net profit/loss of the firm for the accounting period.

• Net profit can be arrived by deducting the administrative expenses from the Gross profit.

• By nature Profit & Loss account is a Nominal account and should not have opening & closing balances

• If the total of credit column exceeds the total of debit column the difference is called net profit, which is transferred to the capital account or added to the existing share capital while preparing the balance sheet.

• Net profit will increase the capital and net loss will decrease the capital.

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Particulars amt Particulars amt

TO office salaries

TO rent, rates, taxes

TO Printing and stationery

TO Legal charges

To Audit fee

TO Insurance

TO General expenses

TO Advertisements

TO Bad debts

TO Carriage outwards

TO Repairs

TO Depreciation

TO interest paid

TO Interest on capital

TO Interest on loans

TO Discount allowed

TO Commission

TO Net profit-------

(transferred to capital a/c)

XxxxxxXxxxxXxxxxXxxxXxxxXxxxXxxxxXxxxXxxxXxxxXxxxxXxxxxXxxxxXxxxXxxxxXxxxxXxxxxxxxxxxxxxx

Xxxx

Xxxx

Xxxxx

Xxxxx

Xxxx

Xxxxx

By gross profit b/d

By Interest received

By Discount received

By Commission received

By Income from investments

By Dividend on shares

By Rent received

Xxxxxxxx

Xxxx

Xxx

Xxxx

Xxxx

xxxxxx

PROFIT AND LOSS A/C OF …………………….FOR THE YEAR ENDED…………

Balance sheet• The preparation of Balance sheet is the last

and third stage of Final accounts.• The balance sheet has to be prepared only

after the preparation of Trading & Profit & Loss account.

• Trading & Profit & Loss account are prepared for a period of time where as the Balance sheet is prepared on a particular point of time

• “Balance sheet is a Statement prepared on particular date to reflect the financial position of the firm with all the assets and liabilities of the firm”

• Balance sheet is not an account but it is a final statement of the financial position of a business on a closing date.

• Assets are shown on the right side, liabilities including Capital is shown on the left side of the Balance sheet.


Liabilities amt Assets amt

Creditors

Bills payable

Bank overdraft

Loans

Mortgage

Reserve fund

Capital xxxx

+ Additional capital xx

+ Interest on capital x

+ Net profit xxx

Less

Drawings xxx

Interest on drawings xx

Net loss xxx

Xxx

Xxxx

Xxxxx

Xxxx

Xxxxx

Xxxxx

Cash in hand

Cash at bank

Bills receivable

Debtors

Closing stock

Investments

Furniture and fittings

Plats&machinery

Land & buildings

Goodwill

Prepaid expenses

Outstanding incomes

xXxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

xxx

BALANCE SHEET OF ………………………… AS ON …………………………………….


Final accounts problemsplease bring your own text books &

calculators


INTRODUCTION TO FINANCIAL ACCOUNTING


Introduction to Final Final Accounts

Finance means Cash, Money, Price, Value and Cost Its relating to Monetary benefitBasically 3 Concepts


Introduction to Final Final Accounts

Account – It’s a summarized statement of Debit and Credit Accounting – it’s a process of all types of accounts such as PA, RA & NA Accountancy – its law of accounts.


Introduction to Accounting

Accounting is a old concept. It was introduced by Edward Jones in 1795 in the books of “Modern Accounting System”.

Accounting is “Method of Identifying, Classifying, Summarizing in a significant manner in terms of Money”.


Principles of Accounting

Recording Identifying Classifying Summarizing Balancing

Eg. 1. Mr. Ramu Purchased a book of Rs. 150/- from kiran at Koti.2. Mrs. Aishwarya Sold a Machinery of Rs. 10000/- to Bharati by cash.


Types of Financial Accounting

Personal Accounts Real Accounts Nominal Accounts


Types of Accounting

Financial Accounting Management Accounting Cost Accounting


Concepts of Accounting

Money Measurement concept Business Entity concept Going concern concept Cost concept Dual aspect concept Accounting period concept Matching concept Reliasation concept Objective concept Other concepts


Conventions of Accounting

Convention of Disclose Convention of Consistency Convention of Conservatism Convention of Materiality


Principles of Double Entry system

Principles

Personal Accounts Real Accounts Nominal Accounts

Debit Credit Debit Credit Debit Credit

Receiver Giver What comes in

What goes out

Exp and Loss

Income & Gain


Journal

When the size of the business firm is big. All the business transections are first recorded in a Rough Book, before entering them in “JOURNAL”.

After words these transactions are recorded in a chronological order.

After analyzing, classifying these benefits according to the principles of debit & Credit is called “Journal”.


Advantages of Accounting

Replacing money Assisting the performance of the business Assessing the financial status of the business Documentary evidence Assisting in realisation of debts. Facilitating & detecting frauds Preventing & detecting frauds Help full to Management


Classification of Ledger

Debtors ledger Creditors ledger General ledger Self ledger


Types of Subsidiary books

Purchase book Sales book Purchase returns book Sales returns book Cash book Bill receivable book Bills payable book Journal proper


Characteristics of Cash book

It can also be treated as a subsidiary book Like ledger, there are the debit and credit columns in cash book Only cash transactions are recorded It always shows debit balance but it never shows the credit balance The balance of cas can be known at any point of time


Types of cash transactions

Cash ReceiptsCash Payments


Types of Cash books

Simple cash book Double column cash book Triple column cash book Petty cash book


Trial Balance

M.S gosav defined the Trail Balance as “The Trail balance is a statement containing the balances of all ledger accounts., as at any given date, arranged in the form of debit and credit columns placed side by side and prepared with the object of checking the arithmetical accuracy of the ledger postings”.


Characteristics of Trial Balance

Basically Trial Balance is a statement or list It contains all the Debit and Credit balances It total debit balances must be equal in aggregate to the total of the credit

balances when accounts are balanced at any given time. Trial Balance is the only base for the preparation of final accounts


Advantages of Trial balance

Preparation of final accounts will become easy with the preparation of Trail balance

When the total balance of debit is equal to the total balance of credit in a trial balance one can confidently rely on the results derived out of such trail balance.


Final Accounts

Relating to Trading Concern Trading Account Profit & Loss Account Balance sheetRelating to Manufacturing Firm Manufacturing Account Trading Account Profit & Loss Account Balance Sheet


Importance of Trading Account

We can ascertain Gross Profit / Gross Loss We can observe the changes in direct expenses. We can calculate the cost of production We can establish the relation b/w the costs and revenues We can analyze the trend in sales We can decide the earning capacity of the firm


Importance of Profit & Loss Account

The main purpose of preparing the Profit & Loss account is to ascertain Net profit / Net Loss of the firm

It is also useful to establish a relationship b/w the sales and the total indirect expenses through percentages.

Its relating to the expenses and Incomes of the firm


Balance Sheet

“Balance Sheet is a statement prepared on a particular date of reflect the financial position of the firm with all assets and liabilities of the firm”.


Types of Balance Sheet

Rigidity preference order Liquidity preference order

Documents

Unit 4 INTRODUCTION TO FINANCIAL ACCOUNTING. Need for ACCOUNTING As you are aware, every trader generally starts business for purpose of earning profit